3/17/2010 @ 5:52PM

Bernanke: Dodd's Plan Is A Dud

WASHINGTON — It may not come as a surprise that the current Fed chairman and a former one oppose stripping the Federal Reserve of its supervisory oversight over all but the biggest banks, but none of the other expert witnesses called before a House committee Wednesday thought it was a good idea either.

“No other agency can, or is likely to be able to, replicate the breadth and depth of relevant expertise” that the Fed has in overseeing complex banking organizations and spotting risks that could damage the economy at large, Fed Chairman Ben Bernanke told the House Financial Services Committee. According to Paul Volcker, an advisor to President Barack Obama who served as Fed chairman during the recession of the early 1980s, taking away that authority would be a “really grievous mistake.”

Earlier this week, Senate Banking Committee Chairman Chris Dodd, D-Conn., introduced a financial regulatory reform bill that would strip the Fed of supervising all banks except for the roughly 35 institutions that have more than $50 billion in assets. (See “Dodd Makes His Play”)

The idea would be to allow the central bank to focus on monetary policy and only the largest firms. Bernanke says he’s “quite concerned” by this aspect of Dodd’s proposal. According to Volcker, if the Fed were relieved of its oversight of smaller banks, its “regional roots would be weaker and a useful source of information lost”–a view also shared by Bernanke.

Right now, the Fed supervises some 5,000 bank holding companies, 850 state-chartered banks and foreign banks operating in the U.S., and it has broad oversight of large financial firms. In December the House passed a financial regulatory reform bill that would preserve its supervisory authority.

The issue, while important, is probably not enough to single-handedly derail financial regulatory reform. For one thing, House Financial Services Committee Chairman Barney Frank, D-Mass., says he thinks the differences between the two bills can be worked out.

Not a single witness before the committee Monday advocated stripping the Fed of its supervisory authority.

“If we mandate that the Fed is not involved in supervision then we make hasty, uninformed decisions inevitable when it is called upon as a lender of last resort,” said University of Chicago business school professor and Fed consultant Anil Kashyap in his prepared testimony. Robert Nichols, president of the Financial Services Forum–a group of CEOs from large banks like Goldman Sachs, Bank of America and Citigroup–said in his remarks that it’s important for the Fed to have a “supervisory dialogue with small- and medium-sized institutions.”

Even the lone witness chosen by Republicans was lukewarm on the subject. “It does not seem to matter much, if at all” where the supervisory authority lies, said Carnegie Mellon professor and Fed historian Allan Meltzer in his prepared testimony. His reasoning: None of the regulatory structures currently in place has been able to eliminate systemic risk, which threatens the entire economy. According to Meltzer, “We will not eliminate crises, or even reduce them, unless we impose prudence on the bankers and their stockholders.”

Both Benanke and Volcker say that instead of re-arranging the regulatory deck chairs, Congress should focus on plugging the gaps in existing regulations, such as establishing a process for officials to unwind faltering non-bank financial firms.

What’s next? Next week the Senate Banking Committee begins marking up Dodd’s bill. If it is passed by the committee, it will go to the Senate floor for a vote. If that passes, senators and House members must sort out the differences between the two pieces of legislation. Reform–if it indeed happens–could be months away.